Timeless economics

Still makes sense.. and we’ll always have Paris..

John Stuart Mill

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Here’s a good exposition of his ideas. By Robert Vienneau.

No wonder J. S. Mill ranks way up there among the classical economists.

Written by Orlando Roncesvalles

November 23, 2010 at 3:42 PM

Posted in history of economic thought

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Keynes and unthinking

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Comments are welcome on a draft profile on Keynes’ life and ideas.

Written by Orlando Roncesvalles

November 20, 2010 at 11:29 AM

A short understanding of the Invisible Hand theory of Adam Smith

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Adam Smith
Philosopher, 1723 – 1790

Adam Smith was born in Kirkcaldy, Fife, Scotland. The exact date of his birth is unknown; however, he was baptized on June 5, 1723. Smith was the Scottish philosopher who became famous for his book, “The Wealth of Nations” written in 1776, which had a profound influence on modern economics and concepts of individual freedom.

In 1751, Smith was appointed professor of logic at Glasgow University, transferring in 1752 to the chair of moral philosophy. His lectures covered the field of ethics, rhetoric, jurisprudence and political economy, or “police and revenue.” In 1759 he published his Theory of Moral Sentiments, embodying some of his Glasgow lectures. This work was about those standards of ethical conduct that hold society together, with emphasis on the general harmony of human motives and activities under a beneficent Providence.

Smith moved to London in 1776, where he published An Inquiry into the Nature and Causes of the Wealth of Nations, which examined in detail the consequences of economic freedom. It covered such concepts as the role of self-interest, the division of labor, the function of markets, and the international implications of a laissez-faire economy. “Wealth of Nations” established economics as an autonomous subject and launched the economic doctrine of free enterprise.

Smith laid the intellectual framework that explained the free market and still holds true today. He is most often recognized for the expression “the invisible hand,” which he used to demonstrate how self-interest guides the most efficient use of resources in a nation’s economy, with public welfare coming as a by-product. To underscore his laissez-faire convictions, Smith argued that state and personal efforts, to promote social good are ineffectual compared to unbridled market forces.

In 1778, he was appointed to a post of commissioner of customs in Edinburgh, Scotland. He died there on July 17, 1790, after an illness. At the end it was discovered that Smith had devoted a considerable part of his income to numerous secret acts of charity.

Invisible hand theory of Adam Smith

One of the greatest contributions of Adam Smith was the invisible hand theory. He said that if the government doesn’t do anything, there’s a controlling factor of people themselves who can guide markets. I believe that the government should be responsible in defining the property rights, to set up honest courts, to impose minor taxes and to compensate for well defined “market failures” If I sell candies for 1 peso each and Christian sells them for 2 pesos for 3 pieces, he will get all the business making me lose mine so in order to compensate for my loss I should be forced to lower my price as to stay alive in the business. I am guided by an invisible hand which is my self interest to gain profit or as Adam Smith would say everyman for himself.

The theory of the Invisible Hand states that if each consumer is allowed to choose freely what to buy and each producer is allowed to choose freely what to sell and how to produce it, the market will settle on a product distribution and prices that are beneficial to all the individual members of a community, and hence to the community as a whole. The reason for this is that self-interest drives actors to beneficial behavior. Efficient methods of production are adopted to maximize profits. Low prices are charged to maximize revenue through gain in market share by undercutting competitors. Investors invest in those industries most urgently needed to maximize returns, and withdraw capital from those less efficient in creating value. Students prepare for the most needed (and therefore most remunerative) careers. All these effects take place dynamically and automatically.

The way I understand the said theory is by giving my own example;

Joan and Joanne are fresh graduates and are trying to open up a business to help them understand and be aware about the invisible hand. About a month they have realized that people from their hometown had to go the mountains to purchase fruits and vegetables. They conducted a survey to find the most fruits and vegetables in demand of the community. After careful consideration and months of planning they decided to open up a fruit and vegetables business naming it Twin’s fruit and vegetables where they would be the one to purchase wholesale goods and sell it to the people. The people were quite glad about it because it would save them the time and effort to go up the mountains to buy rather just go to Twin’s fruit and vegetable. Things were running smoothly for their business and they were happy about it. They offered free delivery within a certain area and maintain their low prices to satisfy their customers for they have realized that only with the continuous support of the people will they be able stay in business and also discourage other businessmen from entering the market.

It is understood that the invisible hand in this situation is the idea of being the only producer of a certain good by being considerate as to lower the price for the people to be able to afford thus making a good reputation to the said company. If the community is already satisfied with the way things are then they will continue to support the said business making it hard for other businessmen to open market

This was taken from the famous wealth of nations

By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was not part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.

This is as how Adam Smith explained it that being led by an invisible hand is actually profitable in the sense that it uses the will of a person’s self interest which drives him to create more and better ideas to overcome the other competitors as long as he would be doing it in a legal way.





Written by jongart

May 25, 2010 at 11:04 PM


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Ronald Harry Coase was born in Willesden, England, on December 29, 1910 in a suburb of London. As a child, Coase had a weakness in his legs, for which he was required to wear leg-irons. Due to this problem, he attended the school for physical defects. At the age of 12, he was able to enter the Kilburn Grammar School on scholarship. At Kilburn, Coase completed the first year of his Bachelor in Commerce degree and then passed on to the University of London. Coase graduated from the London School of Economics in 1932, and earned a higher doctorate from the University of London in 1951.

During 1931–32, Coase traveled to the United States on a scholarship to study the structure of American industry. This study became the basis for Coase’s lifetime fascination with industrial organization and his later work on the nature of firms and their costs.

Ronald Coase received the Nobel Prize in 1991 for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy.

Coase is best known for two articles in particular: “The Nature of the Firm” (1937), which introduces the concept of transaction costs to explain the nature and limits of firms, and “The Problem of Social Cost” (1960), which suggests that well-defined property rights could overcome the problems of externalities.


The Nature of the Firm was a brief but highly influential essay in which Coase tries to explain why the economy is populated by a number of business firms, instead of consisting exclusively of a multitude of independent, self-employed people who contract with one another. Coase asks, why and under what conditions should we expect firms to emerge knowing that productions could be carried on without any organization or firm?

Since modern firms can only emerge when an entrepreneur of some sort begins to hire people, Coase’s analysis proceeds by considering the conditions under which it makes sense for an entrepreneur to seek hired help instead of contracting out for some particular task.

Coase explained that firms exist because they reduce the transaction costs that emerge during production and exchange, capturing efficiencies that individuals cannot. Firms are like centrally planned economies, he wrote, they are formed because of people’s voluntary choices. But why do people make these choices? The answer, wrote Coase, is “marketing costs.” (Economists now use the term “transaction costs.”) If markets were costless to use, firms would not exist. Because markets are costly to use, the most efficient production process often takes place in a firm.

For clearer understanding, take for example a broken car. If you are the owner of the car and decided not to bring it to a mechanic shop (which is a firm) it will take you “marketing cost” to fix it by yourself. You need to buy those parts which need to be repair, tools to be used in repairing, fare in going to hardware stores, and effort and time to do the work. That is what Coase tries to explain on why firm exists. If you bring the car directly to the repair shop it won’t take you marketing cost in doing the repairing.


“The Problem of Social Cost,” Coase’s other widely cited article, was even more path breaking; indeed, it gave rise to the field called law and economics.

Published in the Journal of Law and Economics in 1960, while Coase was a member of the Economics department at the University of Virginia, “The Problem of Social Cost” provided the key insight that it is unclear where the blame for externalities lies.

I take a beach resort as an example. Assume that there is a known tourist spot beach resort which earns a lot of money in its services. Few kilometers away from the resort, there is a small island. Years later this island is dumping its waste into the beach which causes the tourists in the beach resort to have skin infections in their swimming. If that small island keeps their garbage in their place it will also cause health problems to the inhabitants of the island because their area is too small to make a place for their wastes.

Coase argued that without transaction costs it is economically irrelevant who is assigned initial property rights; the people living in the island and the owner of the resort shall work out an agreement about whether to restrict the waste disposal or not based on the economic efficiency of doing so. Since none of them on the ocean, property rights allocation will hence matter only in determining distribution. If the islanders held rights over the sea, the resort owner could pay him to restrict or limit the pollution; if the resort owner held the rights, the islanders could buy the right to pollute.

The Problem of Social Cost” provides more than merely a revolutionary rethinking of the question of externalities. It also suggests a new and interesting approach to the problem of defining property rights.

This seminal argument forms the basis of the famous Coase Theorem as labeled by George Stigler.


In The Problem of Social Cost”, Coase laid a critical foundation of modern law and economics – the so-called Coase theorem. The Coase theorem has been formulated in various ways, but one useful statement might be that: “When the parties can bargain successfully, the initial allocation of legal rights does not matter.” According to the Coase theorem, rights will be acquired by those who value them most highly, which creates an incentive to discover and implement transaction cost minimizing governance forms.

The Coase Theorem describes the economic efficiency of an economic allocation or outcome in the presence of externalities. The theorem states that when trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights. The Coase theorem is an important basis for most modern economic analyses of government regulation, especially in the case of externalities.

“Whether a transaction would be organized within a firm or whether it would be carried out on the market depended on a comparison of the costs of organizing such a transaction within the firm with the costs of a market transaction that would accomplish the same result. All this is very simple and obvious. But it took me a year to realize it – and many economists seem unaware of it (or its significance) to this day…As it was a new approach (I think) to this subject, I was quite pleased with myself. One thing I can say is that I made it all up myself. As I said in my Nobel Prize lecture, I was then twenty-one and the sun never ceased to shine.”
– Ronald Coase

Sources and Suggested Reading:

Autobiography of Ronald Coase, http://nobelprize.org/nobel_prizes/economics/laureates/1991/coase-autobio.html

Milton Friedman : The Man Who Always Had Something To Say!

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Milton Friedman was one of the most influential economist of the 2the 20thcentury.He was born July 31, 1912 in BroolynNew York of Russian-Jew parents. He finished his college degree in Rutgers University majoring in mathemetics and economics. He took up masters in economics at University of Chicago and his Phd at Columbia University.

Early in his career he held various positions in the government, working at the Bureau of Economic research, the US Treasury Department, and the National resources committee, while at the same time teaching at University of Chicago. These stints in various areas of economics are influential in his works and books on economics.

Friedman was widely regarded as the leader of the Chicago School of Monetary Economics, which stresses the importance of the quantity of money supply as an instrument of government policy and as a determinant of bussiness cycles and inflation. Before Friedman’s monetary theory, government is willing to have a little more inflation as long as there is a reduction in unemployment. Friedman said this is an illusion. Pumping up demand (by hiring more workers who now have wages to purhcase goods) pushed down unemployment, only by fooling workers into thinking that wages had risen relative to prices making them more willing to offer their labor.

Once truth dawned (prices have increased because many are now chasing the same goods) they will demand more pay and unemployment would rise back to its “natural” rate. If government tried to push unemployment below this “natural” rate, in the long run they would suceed only in pushing inflation even higher.

Mr. Friedman also conceptualize the theory of permanent income hypothesis. This theory set forth that people do not spend on basis of what their income happened to be that year but according to their “permanent income” – what they expected to have year in and year out. In a bad year they will dip into their savings, when they had a surplus they would save. This idea together with his work on monetary analysis and stabilization policy earned him a nobel prize in 1976.

One of his economic ideas, a product of the conditon of his era, the NEW Deal era, is that the market is always rational and efficient. Perhaps repelled by the heavy government oversight of financial markets imposed during the new deal era and by the evidence of wide spread irrational behavior by paticipants in the financial markets. He believed that the market will be the one to correct and cure itself and not some form of regulation and legistlation. But today it would seem that the idea is on the wrong side ofeconomic history. To qoute one writer, “The financial crisis that has engulfed the world in the past two years is not just or perhaps even mainly a tale of greed run riot IT IS THE RESULT of an IDEA that failed. The IDEA which over the past four decades become the dominant belief among those generally regarded as the savviest participants in the financial system, was that the market is always rational and efficient. So much for that.

But this does not diminished the standing of Milton Friedman as a giant in the dismal Science of Econimics. His ideas and contribution remains to the day as influential, powerful, profound and relevant.





Ricardo’s Hit [Comparative Advantage] and Miss [Labor Theory of Value]

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(1772 - 1823)

David Ricardo was born in 1772 and was the 3rd of 17 children. He belonged to a family of Dutch Jews that migrated to England. He entered his father’s business at 14 years old, but eventually left the Jewish faith to become a Unitarian at 21 years old and married a Quaker.  Because he was disowned by his family, he became a stock broker on his own and in a few years, became richer than his Father.

At 27 years old, he came across Smith’s Wealth of Nations and became more interested in economics. His first published work was a letter to a newspaper on currency problems. James Mill, a good friend of his, urged him to produce more works (he didn’t like writing that much). In 1817, he came out with Principles of Political Economy and Taxation, which became his most famous work.

The Bullion Controversy

Ricardo was first noticed by economists over the “bullion controversy.” In 1809, he wrote that England’s inflation was brought about by the Bank of England’s propensity to issue excess banknotes, because it was no longer a requirement to pay in gold on demand. The remedy Ricardo called for was to return to the gold standard. Then if the price of gold in the market rose, every over-issue of bank notes would be cancelled automatically by the flow of paper back to the Bank. The restoration of the gold standard would then curb inflation.

Ricardo’s plan was adopted by Parliament in 1819, and the gold standard worked for over a century thereafter, except during major wars and financial crises.

Production to Distribution

Ricardo changed the emphasis of economic analysis from production to distribution. Adam Smith stated that the well-being of a nation depends on the total production and the number of people who must share it. In contrast, Ricardo’s Principles of Political Economy and Taxation raised as the key problem the division of the produce of the earth among three classes: land owners, capitalists, and laborers. He emphasized the division of income rather than the growth of income because of his pessimism.

Labor Theory of Value

Ricardo was concerned with relative values, not with absolute value. Utility, he said, is not the measure of exchangeable value, although it is absolutely essential to it. Possessing utility, commodities derive their exchangeable value from two sources: from their scarcity, and from the quantity of labor required to obtain them. Ricardo was unconditionally committed to his labor theory value. The exchange value of a commodity depends on the labor time necessary to produce it.

The simple form of labor theory of value would be logical (although not necessarily correct) under two conditions: if all industries had the same ratios of capital to labor, and if the capital investments in all industries had the same durability. As these conditions are hard to obtain, if not, non-existent, if all commodities sold at their value as measured by labor time, the consequences would be unequal rates of return in different industries.

Examine this situation then. A sports apparel company hires 100 workers to cut and sew 1,000 basketball shorts in a day. A communications company hires 100 workers to assemble 1,000 mobile phones a day. Both companies give the workers 8 hours a day to work on these products. If we apply Ricardo’s labor theory of value, then a basketball shorts’ value would be equal to that of a mobile phone’s value, which means that the selling price of these two different products should be equal as well. And we all know that in reality, this cannot be true.

The problem with Ricardo’s theory is it does not take into consideration the capital of the industries, the costs of raw materials and other factors that influence the price of the commodities (competition, brand, etc.) Labor cannot alone determine the value of a product, especially in this age where technology actually lessens the needed physical input from laborers.

Theory of Comparative Advantage

According to Ricardo, if one country is more efficient than another in producing all commodities, trade between the two nevertheless would be of mutual advantage. The more efficient country should export those commodities in which her comparative cost is lowest, and she should import those whose comparative cost is highest. This is the basis for Ricardo’s free trade policy for manufactured goods.

The theory of comparative advantage, as he described it, seems to be that both those rich in ability and the poor alike concentrate each their own analytical powers on meeting the needs and abilities of the richer, more skillful party to an otherwise unequal exchange and thereby both benefit. Ideas often extrapolated are: that both benefit equally; and that somehow in such exchange each nation, or person, is enabled to focus on its own area of real specialization in a bi-directional equal trade — but we only start with an idea of purely comparative specialization in one direction.

A modern example would be an exchange of commodities between the United States and the Philippines. For the sake of example, let’s momentarily consider nurses as ‘commodities’ and somehow equate them with mobile phones. The US of course, produces more mobile phones than nurses. The Philippines, on the other hand, produces more nurses than mobile phones. So if we consider these two commodities in a trade, comparative advantage comes in when the US trades more of their mobile phones  and less of nurses and the Philippines trades more nurses than mobile phones. This is because US, of course, is one of the leading countries in telecommunications technology, with multi-national corporations continuously advancing and improving the industry. Meanwhile, the Philippines produces quite a number of trained and qualified nurses more than willing to work in the United States. And since the ‘Filipino care’ is world-renowned, there’s actually a demand for more nurses.

In this way, both countries — the Philippines and the US — benefit from each other by exporting more of their strong commodities, and importing those products that are scarce in their own country. And these two countries found exactly that in their trade of nurses and mobile phones. They make use of their strengths and weaknesses to benefit each other. Comparative advantage.

This theory by Ricardo became one of the foundations of global trade as we know it today.

Oh, and for those of you who would like to read the original text, Ricardo’s Principles of Political Economy and Taxation can be found online. =)

Written by zequeenbee

May 15, 2010 at 4:00 PM

Posted in Uncategorized

Homework assignments in History of Economic Thought

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The following are the assigned homework assignments for Econ 12 in the second semester of SY 2009-10:

No. 1

1.      Read McCloskey et al’s “3 -minute history” of economic thought.

2.      What is philosophy? Is there a link between philosophy and economics? If so, explain. If not, why not?

3.      Who was Karl Popper? What is his importance to economic thought?

4.      Read Adam Smith in the original (either of his two books – Moral Sentiments, or Wealth of Nations). Find a paragraph or two you particularly like or dislike. Explain why.

5.      Who are the classical economists? Why is their work called classical economics? What distinguishes classical from neoclassical economics?

No. 2

  1. Assume for the sake of argument that man evolved from “lower” species.  Can a man be a human if he does not engage in economic thought?  What is economic thinking anyway?  Can you imagine that ants who build hills, or birds who make nests and feed their young, go through a process of economic thinking? Why or why not?
  2. When or why is a market price better than a “just price”?  Is it all right to charge interest on loans? Did Aristotle, Confucius, and St. Thomas Aquinas think rightly or wrongly about interest and market prices? Defend your answer.
  3. Imagine a social order where there are “slaves” who do only manual work, and “citizens” who do “thinking” work.  Does this kind of social order have any effects on the economy?  If so, what do you think these effects are?
  4. Imagine a social order where the children of the rich don’t have to work while others have to.  What is wrong with this scenario?  What is right about it?

No. 3

Answer the questions below by reading Chapters 7 and 12 of the textbook.  You may also consult other reliable web resources.

  1. Distinguish “classical political economy (1790-1870)” from “welfare economics (of 1930-1960).”
  2. Summarize Ricardian economics. Give an instance where you think David Ricardo was wrong.
  3. Who were the main figures of the Lausanne School of economic thought? Discuss their main ideas?  Do these ideas have relevance to the case of the Philippines?  Give an example of why or why not, and explain in your own words.
  4. Give the conventional definition in economics today of “efficiency.” Compare and distinguish market failure and government failure.

No. 4

Answer the questions below by reading Chapters 13, 14, and the Epilogue of the textbook.  You may also consult other reliable web resources.

  1. What is the main difference between the ideas in Keynesian economics and the so-called New Classical Macroeconomics?
  2. What is the Washington Consensus in development economics?  Would the Washington Consensus be applicable or relevant to the Philippines?  Why or why not?
  3. Summarize the ideas of Austrian economics.
  4. What economic thought is most likely to be attributed to Joseph Schumpeter?
  5. Who is your favorite dead economist?  Why?

Written by Orlando Roncesvalles

February 18, 2010 at 8:42 PM